With an ambitious growth trajectory and strong financial results of late, Sprouts Farmers Market has an outlook that’s as sunny as its Southwestern home base.

But for investors and analysts, there’s just one catch: Amazon.

Sprouts’ focus on low-price natural and organics seemingly puts it on a collision course with Whole Foods and its deep-pocketed new owner, which has promised to make organic “affordable for all.” So far, traffic data shows that the retailer’s recent price cuts have drawn a significant number of Sprouts’ shoppers.

Despite improving sales throughout the year, capped by a 4.6% comp-store sales increase in the third quarter, the retailer’s stock price has increased 26% this year.

Amin Maredia, Sprouts’ CEO, isn’t troubled Whole Foods’ recent moves. In an interview with Food Dive Wednesday, he noted that Sprouts’ sales have accelerated amid Whole Foods’ discounts.

But he is also keenly aware of the interest in his company as a takeover target.  Albertsons reportedly was in discussions with Sprouts earlier this year, but the two sides couldn’t come to an agreement, according to the New York Post. Maredia said he would be open to acquisition discussions and would weigh any offer with the company board. At the same time, he said it’s possible Sprouts could open its checkbook and purchase another business.

“This is an interesting time to be looking at M&A from both perspectives,” Maredia said. “There’s certainly one element we can control, which is looking for interesting opportunities that would fit well in our portfolio. The second is to the extent we get a gesture, we’ll put our fiduciary hat on and look at the Sprouts brand and evaluate it and do the right thing for shareholders.”

Growing fresh and private label

For now, Maredia’s main focus is on the competition — and specifically on conventional grocers, who he says are Sprouts’ main target right now.

“Those grocery stores have not kept up with the consumer,” he said. “When somebody says the industry is overstored, the first assumption is that all 27,000 [conventional] stores are relevant. Five to seven thousand do a good or a great job, but there are 10,000 to 15,000 stores that are old, dingy, underinvested, have cut labor down to the bone to where you just don’t want to be there.”

Many of those conventional grocers, including Kroger, have slowed their store growth lately amid intense competition and pricing pressure. Sprouts, on the other hand, plans to expand by around 30 stores a year, with the goal of growing its current count of 285 locations to as many as 1,200.

To get there, the Phoenix-based retailer plans to leverage its advantages in fresh foods while investing in new opportunities like private label, technology and an enhanced deli offering.

At the core of Sprouts’ identity are fresh fruits and vegetables — literally. They’re situated in the center of the store, and comprise around 25% of the retailer’s total sales. To keep prices down and quality up, Sprouts sources and distributes all of its produce. According to Ben Bienvenu, a research analyst with Stephens, this gives Sprouts two to three days of additional freshness compared to other grocers, and better prices than many conventional players.

“Once they get the customer coming into the store regularly to buy produce, they upsell them on more traditional staples,” he told Food Dive.

More and more of those staples fall under the Sprouts brand. Private label currently makes up about 12% of the company’s assortment. That’s a lower percentage than many conventional players, but it doesn’t take into account Sprouts’ large produce assortment. According to Maredia, penetration in major categories like snacks is close to 20% or more.

Eventually, Maredia would like to see Sprouts’ private label assortment in the mid-to-high teens. To that end, the company is focused on taste innovation in everything from snacks to baked goods.

“In the chip category, for example, our price is the same or slightly higher than the national brands, and we still outsell the national brands,” said Maredia. “There are two reasons for that: taste and health. What’s going to separate food products at the end of the day is taste.”

According to Barclays research analyst Karen Short, Sprouts’ focus on innovation in taste and health should continue to drive gains for the retailer.

“We believe [Sprouts’] differentiated strategy with private label (and merchandising in general) will continue to widen the gap between [Sprouts] and conventionals but also Whole Foods,” she wrote in a research note to investors.

To capitalize on the growing demand for prepared meals, Sprouts is rolling out enhanced deli departments that feature soups, sandwiches, salads and other options that, according to Maredia, establish stores as a destination for lunch and dinner. Many of Sprouts’ new locations feature this department at the front of the store to encourage grab-and-go purchases.

“The sales productivity at those stores is meaningfully higher than their legacy store base,” said Bienvenu.

Maredia said that compared to four years ago, Sprouts’ new stores are selling 15% to 20% more volume in their first year. He credited this figure to not just deli sales but site selection, operations and overall product innovation as well.

Sprouts is also investing in customer service by increasing wages and adding more employees to stores. It’s improving its fresh management technology, too, and next year plans to unveil a new website.

 

 

Confronting Amazon

As grocers throughout the industry move into online shopping, so too has Sprouts expanded its ordering and home delivery services. However, its partner in this venture, Amazon, has raised eyebrows. Even though Sprouts established its partnership with the e-tailer prior to its Whole Foods acquisition, analysts question the wisdom of being so closely involved with a competitor.

“They’re going to have to resolve that somehow,” Neil Stern, senior partner with retail consulting firm McMillanDoolittle, told Food Dive. “It doesn’t feel very sustainable right now.”

Currently, Amazon’s Prime Now service offers ordering and delivery from Sprouts stores in eight markets, including Dallas-Fort Worth, San Diego and Atlanta. Maredia said the relationship has been a positive one, and has helped Sprouts stores increase their market reach past the typical seven-minute drive that most consumers usually make to grocery shop.

“It’s not only convenient for the customer, it’s also providing a structural advantage for a format like Sprouts because we’re not as dense in a market as conventionals,” he explained. “This helps us close that gap.”

In the past, Maredia has expressed an openness to partnering with another grocery e-commerce provider. But during his interview with Food Dive, he said he wants to maintain and possibly expand Sprouts’ relationship with Amazon.

“We’re still with Amazon in eight markets, and that’s not going to change in the near future,” he said.

In Short’s view, the relationship between the two companies remains strong. Even if something should happen, she wrote, “[Sprouts] has other equally compelling options to continue expanding home delivery.”

This tension over its e-commerce tie-up underscores the bigger question of just how susceptible Sprouts is to Amazon’s grocery expansion. Both times Amazon has announced price cuts at Whole Foods stores, Sprouts’ share price has been among the hardest hit among industry players. And perhaps with good reason: According to data from Thasos Group, Sprouts saw 8% of its regular customers visit Whole Foods stores the week August 28, when Amazon took ownership and instituted its first round of discounts. Only Trader Joe’s saw a higher percentage, with 10% of its regular customers defecting.

Maredia, however, doesn’t put much stock in these results.

“That data is very different from what’s coming through our registers,” he said. “Our comps are continuing to accelerate, our traffic is continuing to accelerate even with these price cuts.”

Subsequent research has shown that despite garnering significant publicity, Amazon’s discounts haven’t done much to change Whole Foods’ overall prices. According to research firm Gordon Haskett, Whole Foods’ prices are just 1.1% lower than before Amazon acquired the chain.

Sprouts is keeping an eye on Amazon and Whole Foods, he said, and will watch closely to see what their next moves will be — like other retailers. But Maredia said Sprouts is mainly focused on executing its own internal initiatives and disrupting conventional grocery stores.

As the retailer moves up the East Coast, with stores planned in new states Maryland, Pennsylvania and South Carolina next year, it enters some very competitive markets, particularly in the Mid-Atlantic region. The way Maredia sees it, though, Sprouts is entering markets full of clunky, outdated retailers.

While much of the focus has been on Amazon, Aldi and Lidl as disruptors of the traditional store model, Sprouts wants the industry to know it’s coming after legacy retailers too.

“When we think about competition, our primary competitor is the conventional food store,” Maredia said.

Industry observers agree that Sprouts’ format is nicely differentiated from competitors. They say it hits on many relevant consumer trends, from grab-and-go options to the focus on fresh foods and emerging brands. However, they’re divided over the impact Amazon could have.

This is speculative, since it’s not clear at this point how exactly Amazon will leverage its Whole Foods acquisition. But the potential for a direct challenge is there. Bienvenu, for one, believes a more price-aggressive Whole Foods will create direct competition for Sprouts.

Stern, meanwhile, believes Whole Foods’ 365 stores could be a major threat to Sprouts, should Amazon decide to accelerate that rollout.

“I think right now, Amazon seems to be on the fence with 365,” he said. “They closed some units and are opening others. If they think that’s a growth platform, that would be a very worrying proposition for Sprouts.”

There are other challenges facing Sprouts, including rising labor costs. According to a recent report from UBS analyst Michael Lasser, 61% of Sprouts stores are in states that have wage increases planned over the next three years. That’s nearly twice the industry average of 31%.

Maredia said this is something the for which the company has planned. Sprouts currently has tech investments in place, including its fresh product management system, aimed at improving productivity and promotions. He plans to make savings from that program available for price investments as well as any possible wage increases.

“This is something that we’re ahead of, and it’s not a large number in the context of overall labor for us,” Maredia said. “It’s not something that keeps me up at night.”

Amidst all the speculation and looming challenges, Maredia said he and his team are focused on making Sprouts an “approachable” store format. This means making stores attractive and easy to navigate, he noted. More importantly, it means stocking and merchandising products that reflect consumers’ increasing demands for fresher, healthier products.

“People are increasingly conscious of what they’re eating, and at Sprouts we want to give them those fresh, less-processed foods while taking away the impediment of, ‘I can’t afford it,’” said Maredia.